Why the First-Mover Advantage Doesn’t Work for Online Grocery

The experiences learned as a late mover clearly outweigh any advantages as an early mover. This is especially true in the U.S. online grocery market, where barriers to entry and market penetration rates are low.

Feb 10, 2014 at 12:12PM

The first-mover advantage is one of the biggest myths of modern day business thinking. Business history is replete with stories of followers who have outsmarted the early movers. Apple didn't invent the first portable music player, but its iPod was a runaway success. Google wasn't the pioneer of the pay-per-click search engine and advertising, but AdWords is now its major revenue generator.

Similarly, the current market shares of grocers and retailers Kroger (NYSE:KR), Wal-Mart Stores (NYSE:WMT), Amazon.com (NASDAQ:AMZN) in the online grocery market don't speak much about the future. In fact, the first-mover advantage won't do a good job predicting the winners and losers of the online grocer battle because of the industry's characteristics.

Cost advantages from economies of scale
One of the key drivers behind a first-mover strategy in a new market is that the early mover takes significant market share quickly and generates sufficient volumes to spread the fixed costs of operations over a larger revenue base. Under this ideal scenario, the first mover benefits sufficiently from scale economies, lowering its costs to a point that makes it uneconomical for late movers to compete. However, the relatively low amount of capital required to enter the online grocery industry and fragmented nature of the industry suggest that economies of scale won't work well in this instance.

While it will take a more significant amount of investment to expand online grocery on a national level, the initial cost of entry is relatively low. For example, Amazon has utilized the warehouse-delivery model for its online grocery initiative Amazon Fresh, avoiding the need for the buildup of any physical stores. Peapod, the largest online grocery retailer in the U.S., has relied on its parent Royal Ahold's Giant Food and Stop & Shop retail chains for delivery. In a nutshell, the current players haven't had a need to invest heavily.

Another validation for the lack of scale economies is the fragmented nature of the industry, suggesting that the absence of high fixed-cost investments required has essentially rolled out the welcome mat for new entrants. The three leading players in the online grocery space, Royal Ahold's Peapod, FreshDirect, and Safeway, have a combined market share of below 20%. Since no single online grocer has a significantly larger market share than its peers, no one has  reached the minimum scale required to derive cost advantages.

Winning customers
Another often-touted reason for an early mover advantage is that the incumbent will build its brand equity and superior positioning in the minds of customers that will protect its market leadership. Again, this hardly applies to the online grocery market. According to Fitch, grocery has the lowest penetration of online sales in various product categories at only 1% of the U.S. grocery market.

U.S. online grocers simply haven't figured out what online consumers want. This is especially obvious if you look at the varied distribution models. Besides the warehouse-to-home and store-to-home delivery models adopted by Amazon and Peapod, respectively, other retailers have experimented with a self-pickup model. French grocer Chronodrive allows customers to pick up their orders from warehouses, while products are ready for pickup at Harris Teeter's (to be merged with Kroger) stores under its "Click & Collect" online service..

The different delivery models are affected by both business characteristics and customer preferences. For groceries, unlike other products, consumers still prefer to 'see and feel' their products to check for freshness, making the pick-up model (like Harris Teeter) more attractive. On the other hand, Amazon will prefer to leverage on its existing warehouse facilities. This explains why it has relied on the warehouse-to-home delivery and why warehouse pick-up is also a possibility in the near future.

Potential winners and losers
Interestingly, while more people are referring Amazon as the Wal-Mart of online retailing, Wal-Mart isn't about to concede. While its U.S. grocery-delivery service To Go is currently only available in certain cities such as Denver and San Francisco, Wal-Mart has the luxury of leveraging its learning experiences from operations located abroad. These include its operations in Japan (Net Super), the U.K. (Asda), and also China, where Wal-Mart has a 51% stake in Yihdaodian, a leading online grocer.

Once Kroger completes its merger with Harris Teeter, it will have two different online grocery-distribution models: King Soopers HomeShop's store-to-home delivery model and Harris Teeter's "Click & Collect" online service. It remains to be seen if Kroger will choose one over the other or keep both.

Amazon Fresh benefits from its long history in online retail. Furthermore, Amazon Fresh has adopted the same ratings and reviews systems for its grocery products, which brings a small element of network effects. As more grocery buyers use Amazon's online grocery service and contribute reviews, it will bring more customer traffic to Amazon Fresh as the destination site for grocery reviews. This is something that has worked to great effect for its books division.

Foolish final thoughts
Faced with uncertainty over the growth trajectory of online grocery and customers' favored distribution models, the most pragmatic approach will be avoiding over-investment. Instead, online grocers should stay on top of any new developments in the industry and remain well-prepared. Along this line of thought, my bet is with Wal-Mart, which can learn from both its peers in the U.S. and its own overseas experiences in coming up with the right business model.

But what about Wal-Mart's cash problem?
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they’re planning to ride the waves of retail's changing tide. You can access it by clicking here.

Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information